Aligning Corporation Tax and Income Tax

There are many reasons for aligning the main rate of corporation tax with the basic rate of income tax (currently 20 per cent). Any one of these reasons alone would be sufficient to justify reform. Together they make an overwhelming case:

The tax bias against equity causes companies to leverage more than they would prefer if decisions were not distorted. This issue was identified in the recent ICB report.

The tax bias against equity distorts investors’ decisions.

Lower rates of corporation tax (whether or not tied to the basic rate of income tax) would reduce taxes paid by investors which has direct advantages for pension funds, beneficiaries of unit trusts etc., as well as indirect effects in making the economy more capital intensive in an environment in which capital mobility is sensitive to international corporation tax rates.

Aligning the main rate of corporation tax would significantly reduce tax compliance costs and reduce the size of the tax code. Unlike some of the changes in the 2011 budget, this would actually involve an area of taxation that affects large numbers of individuals and companies.

Given the government’s plans to reduce the rate of corporation tax and given the dynamic benefits from its reduction, tying the corporation tax rate to the basic rate of income tax would not have substantial revenue implications.

After two decades of ever-increasing complexity in the tax system – a level of complexity that has made the system incoherent – tying the main rate of corporation tax to the basic rate of income tax would be a strong signal that the government wanted to make the UK tax system simpler and more coherent.

In the long term, there should be radical reform of the corporation tax system which might involve abolishing the tax altogether.